2023-11-28 21:49:08 ET
ON Semiconductor Corporation (ON)
2023 UBS Global Technology Conference Call
November 28, 2023 15:35 ET
Company Participants
Hassane El-Khoury - President & Chief Executive Officer
Thad Trent - Chief Financial Officer
Conference Call Participants
Timothy Arcuri - UBS
Presentation
Timothy Arcuri
Okay, we're going to get started with the next session. I'm Tim Arcuri. I'm the semiconductor analyst here at UBS. I'm pleased to have ON Semi. We have Hassane El-Khoury, President and CEO; and we have Thad Trent, CFO. So, thank you to Hassane and Thad.
Hassane El-Khoury
Thank you.
Thad Trent
Thank you.
Question-and-Answer Session
Q - Timothy Arcuri
Well, let me just start out with a high-level question. Since you both came to the company, you've been on a journey to have more market focus, price better to value, slim down and optimize the manufacturing network. Can you talk about where you are in that journey? Are you sort of done with the optimization and it's more about growth from here? Or is there more optimization left to be done?
Hassane El-Khoury
Yes. Look, we've done a lot. But it -- the journey is always long because it's never mission accomplished. So where we are. We've done a lot of optimization we refer to as Fab Liter, where we divested for fabs. We really focus our manufacturing on where our portfolio is going to be which, like you said, is purely based on value drivers versus just mass market or fab pillars. So we've done that transformation, right now a strategic focus on the growth. However, from an optimization perspective, we talked about in our last Analyst Day, how we are going to Fab Right? What does that mean really is when you have a complex manufacturing network if you have 2 fabs, both running 7 technologies, neither of them are efficient. So streamlining technologies and where you want to manufacture it, reduces cost across the board in both fabs. Do 3 here and 4 here, for example, gets you all 7 much cheaper from a cost efficiency perspective, therefore, increases the margin. So that's still yet to come.
Now from monetizing on the efficiencies we've had already the 4 fabs we've divested, we talked about $160 million of benefit. That will happen over the next few years as we fully exit the fab. We handed the keys over to somebody but you still have to get the products move to our internal manufacturing, that's when you get the benefit. So that is still yet to be reflected on the P&L. But net of the day-to-day or the operational efficiencies we still have, we're happy where the portfolio is. We're double down on silicon carbide. We're doubling down on the analog domain that goes with our power domain. We have reshaped our Image Sensing Group to be high margin, high profitability. And the focus right now is R&D, innovation and new products.
Timothy Arcuri
I mean I guess even in your legacy product portfolio, you sort of increased prices to over time, price yourself out of the market and things aren't actually going away as fast as we thought. So maybe you didn't raise prices enough, I don't know. But how does that -- how is that journey also influenced your -- you to how you operate?
Hassane El-Khoury
Yes. We always talk about pricing. We never -- we don't do cost plus. We price on value. Now value can be a system-level value where the customer sees the value in the system and they will pay more for it because they can monetize it on their side. Specifically for these, you're right, we have said we price ourselves out of the market. because we knew that the customer has other opportunities and other chance to buy it from elsewhere. And the margin profile for that business was not favorable or was dilutive for our portfolio.
So what we've done is we price ourselves out of the market. We walked away already from about $450 million of that business. There's a remaining business that if we don't lose by the end of this year, it's good business. Now why did the customer not go if we indeed price ourselves. We believe that it's not -- we didn't raise it high enough. It is because there is perceived value in there, even if it's not at a system level, being able to place an order ON Semi and get it, high-quality, always a road map and competitive products tells me that that's the value that the customer is putting on it.
And the switching costs are way higher than the benefit that they will get on the system level. If you got something for $0.05 and you take it to $0.10 in a $200 BOM, are you really going to jeopardize that for a $0.05 saving? That's the key. That's the value, it's the consistency, it's the supply assurance and the high quality which does have a price impact on it.
Timothy Arcuri
And you had talked about those 4 fabs. Fishkill has been a persistent headwind to gross margin. It's been a long journey there to bring the fab up to your needs. What is left to do? I mean they were making RF CMOS and you make power analog and maybe some other stuff and it's very different in terms of the complexity of the products versus what they were making there before. Is it really about the commitment to the prior owner falling off, so that it becomes less of a drag on gross margin? Or is there more optimization of the tool set that you have to do within Fishkill?
Thad Trent
Yes. I would say it's more about the cost structure in there, right? So yes, it's a different product set, different technologies but that's always been in the plan, right? So the company had acquired this or made the definitive agreement acquired 3 years ago, we took ownership this year. We got surprised by the cost structure. You think about that as being cycle times, chemical costs, material costs, all of that. We have a large manufacturing footprint. We know exactly what that cost should be. We've got to go optimize that cost and get it into the benchmark of where it needs to get to.
Now it's a fully loaded fab today. So you can't break it, right? So we have to be very careful. So I would say it's blocking and tackling in terms of how we've got to go take that cost out. Of course, we're bringing equipment and things like that. But that's always been in the road map. That isn't the challenge. We think by the time we exit '24, we'll have that back under control and it will be at our cost structure and no longer a drag. So currently, it's about a 250-basis point drag on gross margins which is significant but it's blocking and tackling and we know what to do. We're on track to drive that cost out.
Timothy Arcuri
So if -- the commitment to the prior owner, if those volumes persist for longer, that doesn't -- that's not the issue. The issue is...
Thad Trent
No. No. Because, look, as a part of the transition, we've been winding up over 3 years prior to taking ownership. Now they're going to wind down 3 years while we continue to wind up. So it is a defined capacity that they will take. We're doing foundry services for them. Obviously, we don't want to do that long term. We want to load it with high margin, high-value product versus doing foundry services. So that's the process by which we'll move products in, we'll qualify new products. Everything new will be going into East Fishkill. Everything possible will be going in. But that's the plan ramp that we've had for many years.
Hassane El-Khoury
Yes. And if I talk about progress of our products going in, we are already running low, medium and high voltage. So our power products are already running in East Fishkill qualified and shipping for revenue, part of our baseline today. And we have started sampling our image sensor within [indiscernible] out of that fab as well. So the progress on moving products in and starting to generate revenue on these products has already in the journey and the work that we have to do is really on the cost structure like Thad said. As you get that cost structure back to benchmark against our own fabs elsewhere, all these products will just get that benefit and the margin expansion will happen. That's how we get out of that 250-basis point dilution.
Timothy Arcuri
Got it. Let's talk about silicon carbide. We could talk for the rest of the time about silicon carbide. Obviously, your big push since buying GTAT 2 years ago. It's now up to low teens as a percent of revenue in the Q4. You have a unique model because you have the wafer device and back end. And can you talk about sort of what's the true source of your competitive advantage in silicon carbide? Why are you winning? And why are customers willing to commit what is probably -- I mean you're not giving a number anymore, it's probably at least $10 billion still worth of LTSA?
Hassane El-Khoury
Yes. Let me -- I'll take it in a few pieces. I have always been consistent as we win because of the technology, meaning you have to have the best technology out there. And when I define technology, I talk about device and package together. Because that's what the customer sees in their end vehicle or in their end system, if it's an energy system -- energy storage. What that means is you need to be able to drive that efficiency. That efficiency is driven by technology which is device and package. That's why we win against a lot of our peers.
Now where does GTAT play? That's the supply assurance why we win big. Meaning if you're able to have the best technology that the customer can get the best efficiency on their system and you are able to have a supply assurance and resilience to commit to that customer, that's how you get to a leadership position. If you don't have the best product, it doesn't matter if you have all the capacity in the world. Nobody is going to -- no customer is going to say, "I will sacrifice my end product competitiveness because you have a supply assurance." But having the best product and the supply assurance together, that's the vertical integration strategy that we embarked on, that's the winning platform. But it always starts with compelling and innovative technology. That's what we have. That's how we started with.
Timothy Arcuri
I guess, I said it a different way, the whole -- this perceived risk of China, who's -- there's -- some of the equipment companies talk about 15 new silicon carbide, fabs in China. You're sort of indifferent to that because even if they are successful, you can always buy their wafers and you have the best device, you have the best packaging.
Hassane El-Khoury
Yes. So one thing we have to be clear, when you say they're not fabs. I know it's fungible but they make substrates. If you look at our substrate facility, it's not a clean room. It's a big kind of depots, more than a depot but it's not a clean room environment. So that's why I wouldn't call it a fab. But you're right, there is capacity coming online in China. And if it's high quality and the price is lower than what we can make it internally because remember, it's people talk about, "Oh, it's competitive in China." Well, it has to be more competitive than what we do with the vertical integration which today, we have the best gross margin in that business and anywhere in the world, fully loaded. So I believe we have a cost advantage.
I believe we have a technology advantage. If it becomes available, high quality. And of course, we have to disregard the geopolitical risk for it. Then we have a different source that we can source from which is fine. Today, we are sourcing from China, some of the substrate because we want to evaluate everything that's out there. First, to benchmark against but also we said over 50% is from internal sourcing which means that there's 50% external, not just in China but in other areas of the world but we always look at what's available out there but it has to come to cost and cost advantage, really, otherwise, we have it internal.
Timothy Arcuri
And is there some asymptotic percentage that you're pushing toward to have captive on the substrate side?
Hassane El-Khoury
Yes. We've always said we want to be about that, call it, 80%, give or take. And that number is defined by, of course, availability outside, competitive outside, CapEx. But reason kind of that 80%, plus or minus, is important because we're not going to build capacity to a peak in demand when if you have 2 or 3 customers ramping all at the same time and then the steady state kind of goes to a different level. You don't want to have a peak capacity installed because then by definition, you have underloading all the time. So when you have 80%, we can spring up externally and then have always fully loaded manufacturing and that's the best, call it, P&L performance you can have.
Timothy Arcuri
So you're working on 200-millimeter. I think you're shipping samples at the end of next year. And is it pretty easy for you to swap out a couple of parts on the 150-millimeter tools and just use them for 200-millimeter? Are you adding some automation to that factory to help improve the yields and quality? Maybe just where does that ramp stand? And most importantly, I think people have this perception that there's risk to that ramp. So can you talk about that too?
Hassane El-Khoury
Yes. I smile because I always find it kind of funny when people ask me, "Are you going to add automation to your fab or to our back end?" We ship about 60 billion units a year. And we have probably one of the best margins of most of our peers in the broad power space. Having said all that, you can't perform that well unless you have full automation. So from our baseline today, our fabs are state-of-the-art fabs, even our 6-inch silicon carbide is fully automated soup to nut, so investing in automation is kind of a non-event because it's already automated. But to tackle the question directly, going from 8 inch, you have -- well, I would say, in 2 phases. You have the bull growth which is the substrate growth side of it. And then you have anything from that ON. From wafering, Appy and fab, we're already 8-inch capable. We do it currently on IGBT. So our fab is 8-inch capable and it's running high mass volume of 8-inch. We've already been running 8-inch silicon carbide in that fab. So from a risk perspective and yield readout and so on, we have that whole thing baselined already.
The conversion, if you think about the CapEx light that we have to do is on the furnace. If you look at the -- we build our own furnaces. We've been building our own furnaces for the last few years, part of the GTAT acquisition. If you look at a furnace itself, you will see no difference between the 6-inch today and the 8-inch tomorrow. Inside is going to change, just higher diameter kind of capability inside. That's where the CapEx intensity -- the lighter CapEx intensity comes in. We don't have to build a structure, plumbing is just the core of the furnace. That we've been doing already. So we have furnaces already running 8-inch. They're running 8-inch internally. That's how we baseline the fab and flush everything through. And we're still on track to get those samples in '24 and production '25.
Timothy Arcuri
How much of a cost advantage is that going to provide? I mean, obviously, cost is king but the subset I think, is 40%, 50% of the cost of a silicon carbide of MOSFET. So how much of a cost advantage, it isn't like going to a larger wafer an integrated circuit. I mean there are significant cost advantage there. Here, there's more of a marginal cost advantage, can you kind of talk about that?
Hassane El-Khoury
Yes. The focus for us on going to 8-inch is really about capacity rather than cost. And we have a very good cost structure on 6-inch. Today, we talked about the margin performance of that business. Last couple of quarters ago, we talked about the operating income for that silicon carbide fully loaded business being in the high teens. So from a cost advantage and we're winning. Like you said, the LTSAs are -- a large number of LTSAs. So the move for us to 8-inch is driven primarily by capacity increase. So we don't have to add more furnaces to get that capacity, we can go to 8-inch lower CapEx. You just get a boost in output automatically all the through fab. That's the main driver in the short term.
Over the long run -- you're exactly right, over the longer term, 8-inch will start becoming more favorable from pricing as it gets more maturity on the technology. But in the short term, our focus is on enabling the ramps and enabling the business that we've won with the lowest CapEx back to the what we had presented in Analyst Day, we've got one of the best ROICs in the industry today and we maintain that as a metric.
Timothy Arcuri
I wanted to shift to autos and maybe there were 2 issues last quarter. There were 2 different issues that I think people sort of combine -- maybe in one issue, there was the silicon carbide issue at the one OEM. And then the number two, there was just general softness from Tier 1s in Europe that were not related to silicon carbide. So on those 2 points, really 2 questions. First, can you give any more color on the silicon carbide issue? It sounds like it was a U.S. OEM, maybe related to a new launch? And would you characterize it as cyclical, meaning that you get that back or structural meaning that it's gone?
Hassane El-Khoury
Yes. Let me -- so it is one OEM. I don't want to characterize regional for the obvious reasons but it is a single OEM. It is purely driven by demand. So it is not a supply. It is not a share loss or anything like that, purely end demand. What we have considered, what we talked on the call is we derisk 2024. What that means is we're not assuming that we're pushing it out and it's going to recover in 2024. If it does, great, that's positive. But from a risk mitigation perspective, we just took it out of the number and the baseline is going to be just different. Now '24 number didn't change because we were able to allocate that capacity per se to other customers that need it. So that's the puts and takes from that.
So overall outlook for that business, even short term in '24 and the longer term remains unchanged because for silicon carbide because we've always said that it's capacity constrained. So there are other customers that we weren't servicing 100% that now said, "Hey, we'll take that because we have strength in our business." So we're able to recover the business a different mix, not with that OEM but with others. So the mix is different but the outlook remains the same.
Timothy Arcuri
So you had said -- I mean you're not reiterating the number but there was a time when you said $4 billion between '23, '24, '25. So the point being that the outlook that hasn't changed?
Hassane El-Khoury
It hasn't changed. What we talked about given all of the market outlook, we just said it's going to be 2x, the market? Our growth is going to be 2x the market. Now if you put 2x the market on where we're going to end in '23, it puts it back exactly where it is. That's why I said it doesn't change. The metric we're giving, the 2x market is a different metric. But in '24, it leads to the same number.
Thad Trent
That's something it's worth pointing out that at that one OEM, we're still ramping. So our revenue was up in Q3. It will be up in Q4 if that one account. And in '24, it will grow over '23. So there wasn't a lot here. It just in demand is what came down.
Hassane El-Khoury
But it's still a growth account.
Thad Trent
Yes, still growing.
Timothy Arcuri
And in that case -- or not just in that case but in a case where a customer in LTSA [ph] says, I don't need as much as I thought I did. What do you get in return? So is this a situation where you say, "Okay, fine, you can push that out. But for me to let you to do that, you have to give me something in return."
Hassane El-Khoury
Yes. And this is -- and again, I'll cover it as a general engagement with the LTSAs. I've always said in these conferences or other conference that the LTSAs are legally binding. The minimum they get us is a phone call versus the backlog disappearing. If we didn't have an LTSA, the backlog disappears and then we'll sit and go what the -- what's going on here. You get the phone call so you start the engagement. So when we get the phone call, we figure out is there any stranded inventory, we can't have stranded inventory. That will be win, lose.
So we have to work on no stranded inventory. We have to work on share. Sometimes we got share gain. We -- in some accounts, we say, okay, we had 60% share. Well, if your denominator goes down, our share has got to go up to 80% to make the number. So we get more share. If the demand is net down and we have high share or we are a proprietary solution provider, then, okay, is there somewhere else, different technologies that we're able to ramp where we were may be a secondary supplier because from a customer -- especially customers co-invested with us, they want to monetize that investment, so they will move share to us. That's a win-win.
So in certain cases, we did get more share at those customers, either within the quarter if it's fungible or at least in the following quarter or as we either qualify or if we're qualified, we win. So those are types of win-wins that we engage with at the customer level.
Timothy Arcuri
And on the point of LTSA, so they came down from $20 billion, I think, to $18.4 billion last quarter. Silicon carbide also came down in that number. But did it come down simply because customers are working off of the LTSA? There was no backfill to those this quarter because things aren't as tight as they were and so customers just don't feel a need to book inside of LTSAs.
Thad Trent
I think there's a couple of things you got to keep in mind. One is we shipped, right? So you got another quarter behind you in terms of what you shipped off. The other thing is, as we sign up LTSAs, they're further out as well, right? So -- so that's a lifetime number. But when we get further out there, we discount those back, right? So just not counting -- not just adding them up and counting them, right? So there's a number of puts and takes there and there's also some adjustments to the LTSAs. But I would say that trajectory is still very solid. And we announced on our last call, we're still finding new LTSAs. We have customers that are expanding their LTSAs, extending their LTSAs or even those that didn't have them, that are coming in and saying, "I want to get on an LTSA" even in a down market, we're seeing customers sign LTSAs.
Timothy Arcuri
Okay. Maybe for you, Thad, you said that revenues will be down in March, normal seasonal is down 2% to 3%. Clearly, there's a lot of inventory adjustment happening right now. What are some of the puts and takes? I'm not asking you to guide March. But what are some of the puts and takes on March? And relative to that, sounds like gross margin stays in the 45.5% range roughly in the first half of the year and maybe grows a bit in the back half of next year. Is that kind of the right way to think about it?
Thad Trent
Yes. So look, we're not guiding March. But normal seasonality for Q1 is down 2% to 3%. I think line of sight kind of tells us we're probably in that ballpark right now based on what we're seeing. Our Q4 guide was down about 8%. So coming off a low base. So I think that tells you where we're thinking and what we're seeing. And we also said we're going to take utilization down further. So that's the number one driver in the short term is utilization. So we'll take utilization from about 72% to the high 60s and we'll manage there until we see a recovery in the market. So I think in the first half, we're probably going to be running in that range. You've got this headwind from silicon EFK [ph]. You've got a couple of other things. But if you step out into '25, there's a number of drivers in margin. EFK rolls off. Silicon carbide becomes accretive at that point, not just at the corporate average but becomes accretive. We've got the 4 fab divestitures that Hassane talked about. That's $160 million of fixed costs that we start to recognize in '24 and '25 and beyond.
So beyond '24, there are really a lot of growth drivers again and assuming that we take utilization back up and a recovery back up into the, let's call it, high 70s. We peaked out somewhere 83%, 85%. There's a nice tailwind on margins.
Timothy Arcuri
So there's a camp in analog and power that is the lead times are still compressing and therefore, our business is still getting worse. Bookings are in free fall and even March is biased to the downside seasonally. Then there's another camp that well, lead times have basically stabilize, bookings have stabilized, bookings have come back in the last few weeks. So there was different tones that we heard from some of your peers. So are you more in the bookings have stabilized because lead times have stabilized? Or are you more in the things are still getting worse [ph]?
Hassane El-Khoury
Look, we're not optimizing for lead time. I'll tell you that. So our lead time really have remained plus or minus a week or 2. So from a lead time perspective, we're not optimizing for lead time because a lot of our products are proprietary products and the LTSAs give us much longer visibility on what the backlog puts in. We have LTSAs on average, 4 to 5 years. So we know 4 to 5 years kind of what the run rate is, plus some adjustments that we do in the short term but we're not waiting for backlog. So because -- what -- how do you bring lead times down, you build inventory. And the worst time to build inventory is in a softer market. We actually did a proactive approach of we took utilization down to keep a lid on inventory until we see a recovery rather than keep the fabs kind of running at a virtually higher capacity or utilization just to build inventory and reduce lead time.
We're taking the approach of 2024 is kind of -- we're not planning a second half recovery, if there is one, like that said, we'll turn everything on and it will be all tailwinds. But we're taking a much cautious approach. I don't think things are deteriorating. Back to your comment. I think things are stable, some pockets industrial. We talked about it before. People asked, we didn't talk about industrial last call, it didn't get worse. It's down but it didn't get worse from where we thought it was going to be. So I would say things are stable but I wouldn't say in a recovery mode.
Timothy Arcuri
Auto sound like maybe they are getting just to touch worse because there is some knock-on effect in Europe. Would that be fair to say that autos are still maybe skewed to downside in terms of the market?
Hassane El-Khoury
Yes. I mean if you look at auto, I mean, you have the EV that's going to be growing. The rest is going to be with the market, the general market. We talked about interest rates kind of putting a damper on the end demand but that's a mix difference. EV are still strong for us. So if you look at our Auto number, we're actually very favorable on Auto overall because of the EV strength [ph]. Silicon carbide is going to grow in automotive in 2024. So it depends on where you see. I think the big range that you see in the market depends on what people feel on the overall market. Even the range for us for 2024, when you look at some of the reports out there, they pack to, "Are you positive on '24? Are you extremely negative on semis, not company specific. That's really the range you got to look at.
Timothy Arcuri
Yes. Okay. Thad, there is -- there are a couple of pretty big moving parts on gross margin. We actually talked about some of those, there East Fishkill, there's the 200-millimeter silicon carbide ramp, utilization is still low, as you said. Can you talk through how those all play out and whether you think that 48% to 50% is still a doable long-term model?
Thad Trent
48% to 50% is absolutely. I mean, our long-term target is 53%which we think is still very doable. So if you look at where we are today, as I was saying, the biggest impact is utilization today, right? Taking utilization down further. But yet we're holding that mid-40% floor out of margin. And I think this is because we took utilization down. We started taking utilization down in Q2 of '22. And that's really allowed us to kind of adjust to first consumer and compute getting soft in industrial and now some pockets of auto.
As you look forward and you think about where we are, silicon carbide will be at the corporate average in Q4 for the first time. So, it's been -- we said on our last call, it starts with the 4 today. So it's got a 4 handle. So it will be out there. As we go through next year and we bring additional capacity on in '24, we think it will be at the average and then '25 becomes accretive. As we've said, our silicon carbide gross margins are at or above corporate target.
You got East Fishkill that rolls off in '24, that's 250-basis points. You've got the fab divestitures of $160 million. We'll see most of that in '25. We'll see a little bit in '24 but most of it starts hitting in '25. And then you've got in of new products. So everything coming out of R&D is all at favorable gross margins, right? So we're not doing anything that's dilutive to gross margins. And we've talked about some of the opportunities that we have in the analog space to go into higher-margin categories with large teams. So that gives us that tailwind coming out of '24 really to have that gross margin expansion.
If you do that math right there that I just gave you, we're getting really close to that target as we are, right? So we don't need -- the market's going to do what the market is going to do in the short term but we feel really good about the long term.
Great. Well, thank you all for the time. I really appreciate it.
Hassane El-Khoury
Thank you.
Thad Trent
Thanks.
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ON Semiconductor Corporation (ON) 2023 UBS Global Technology Conference (Transcript)